Worst income dip in 20 years doesn’t stop spending

Consumers keep at it despite tax increase at start of year

WASHINGTON (MarketWatch) — Consumers increased spending in January for the third straight month, suggesting that a big drop in income and a tax hike at the start of the year only exerted a mild drag.

Consumer spending advanced a seasonally adjusted 0.2% last month, the Commerce Department said Friday. That matched the estimate of economists polled by MarketWatch.

Americans continued their spending ways despite an increase in their taxes and the biggest plunge in income in 20 years.

A two-year law that reduced payroll taxes by 2% expired in January and the government also raised rates on the very rich. For people earning $1,000 a week, the payroll tax hike takes an extra $20 out of their paychecks.

Incomes, meanwhile, sank 3.6% in January after spiking 2.6% in December. Companies accelerated the payment of rewards for workers and investors in December to avoid higher tax rates in January, accounting for the big swing.

Consumer spending represents as much as 70% of the economy. When Americans buy more goods and services, businesses generate higher sales and profits and can afford to hire extra workers. Less spending results in slower economic growth.

Danger signs?

Although spending largely held up in the first month of the tax increase, many analysts think it will exert some downward pressure on the economy in the next few months. Consumers don’t always change their behavior immediately after a tax increase.

In one potentially troubling sign, spending on durable goods such as appliances, furniture, or consumer electronics fell 0.8% in January to mark the first drop in three months. Consumers tend to cut back on big-ticket items if they feel more economic stress.

What’s more, higher gasoline prices and sharp cuts in federal spending could also apply the brakes to the economy in the coming months.

On Friday, the government is supposed to begin the process of slashing federal outlays by as much as $85 billion over the next six months under the rules of a so-called sequester. Top Democrats and Republicans were scheduled to meet at the White House to discuss the matter, but no breakthrough was expected.

Economists say the spending reductions could hamper the ability of the U.S. to grow any faster than the 2.2% rate by which it expanded in 2012. The economy needs to grow much faster to quickly reduce the nation’s 7.9% unemployment rate.

“One thing is perfectly clear — most American will remain cautious in their spending habits,” said Chris Christopher, director of consumer economics at IHS Global Insight.

The incomes of earned by Americans, meanwhile, posted the biggest drop since January 1993. Economists polled by MarketWatch had expected incomes to shrink 2.6% because of sharply lower dividend and bonus payments last month.

Personal income derived from assets such as stocks, for example, plunged by $365.5 billion last month after jumping $273.8 billion in December, according to Commerce data.

Adjusted for inflation, income after taxes slumped an even larger 4%. Yet excluding special factor such as the accelerated dividends, real disposable income rose 0.3% in January and matched December’s increase.

Getty Images

A woman carries a shopping bag past a store with a sale sign in the window in Manhattan on February 13, 2013 in New York City.

Still, the combination of modest rise in consumer spending and a steep drop in income reduced the savings rate of Americans to 2.4% from 6.4% — the lowest level in more than five years.

Households typically work to rebuild savings when they fall to such low levels, but rising home values and the surging stock market is making Americans feel a little bit wealthier. What’s more, a slowly improving labor market is giving more people the hope of finding a job or getting a better one. That might make them less inclined to sock more money aside.

Wages, on the other hand, are still not growing very fast. Incomes after taxes, adjusted for inflation, rose just 1.5% in 2012 after a 1.3% increase in 2011. And even those meager gains could be largely eaten up by the price at the pump if gasoline continue to advance. The average cost of a gallon of gas has jumped 14% since the beginning of the year.

Yet overall inflation is still relatively tame. The PCE price index was flat in January, putting the 12-month increase at 1.2%. The core rate, which excludes food and energy, edged up 0.1% in January and is up 1.3% in the past year.

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